Re: EXCITING: What to do with $4,000,000? - Posted by ray@lcorn
Posted by ray@lcorn on July 15, 2004 at 15:12:18:
Eric,
Interesting post in that your situation mirrors the challenge our family business has been grappling with the last few years. We’ve gradually converted a highly management intensive portfolio of properties and businesses into a more “hands-off” investment orientation. We’re also getting ready to sell a multi-family project and need a 1031 candidate to identify, so I am in the same hunt.
We’ve done a number of NNN retail deals in the last three years, and fortunately caught the boom on the way up. As you have found, there is a lot of money chasing a finite number of deals. Financing is plentiful and cheap, and the combination has driven caps into the 6’s for the best tenants and markets. I personally do not expect to see any major easing of price pressures in the near futures for the prime credit deals, so you have to “go where they ain’t.”
If you get away from the hottest markets and the hottest tenants (i.e. Walgreens, Home Depot and the like) there are some workable deals to be found. We’ve been looking at markets that presently have problems, but have the community infrastructure in place to be among those that recover over the next few years. In areas like this it is almost a buyers market with asking caps in the mid-nines and closing caps above ten. With a credit tenant in place (especially those with recession-proof business models, e.g. Dollar Tree, RentWay, etc.) the downside is minimized and the upside can be significant. Unfortunately these types of deals are not large enough (usually less than $600,000 or so each) to satisfy your needs unless you were to do several of them or buy a portfolio. (There are some out there… search NNN on www.loopnet.com in your markets) It’s a gutsy play, and market research is the key.
The NNN principle also works for office buildings, but again you have to do careful market research to avoid the worst of the distressed markets. Nationwide the office sector is in the worst shape of all commecial real estate, and I believe will be the slowest to recover. I have a working hypothesis (yet to be proven)that there could be some play in specializing in one particular type of office product. I like those that require heavy tenant investment in equipment and the facilities and have a need to be in a specific location (e.g. medical, legal, research). This insures the tenants will not move at lease end for a buck a foot discount across town. I also like county seats and proximity to courthouses. Whatever happens in the economy at large, I don’t see the courts slowing down a bit. We just closed on a building like that last week, so check with me in a year or so and I’ll tell you whether we got it right!
I’m also trying to educate myself on industrial property. That’s not a sector I have much experience with, and I’m finding that because of the major shifts in distribution and manufacturing needs over the last few years, the whole sector is in a state of flux. To me this smells like either an opportunity for great profit, or the potential for equally great disaster, so I’m taking my time in doing my own due diligence on the industries I want to be involved with. We will likely decide to specialize in one type of product in this category as well. There are some big players in the sector, and as with getting into anything new, I try to learn from what the big guys are doing and apply it to my own situation. I don’t have the time or the wallet to make all the mistakes there are to be made.
We will be spreading our acquisitions across a couple of sectors and several markets. We considered doing one or two large deals ($10mm+), but when it came right down to it we got skittish about making that large of a bet on one or two markets and tenants. So we’re taking a hedging approach, but using the same investment model and criteria… that being well positioned real estate in stable markets or those with as yet unrealized growth potential (as above), leased NNN to quality tenants (not necessarily credit rated), utilizing medium leverage (65-75%). The acquisition must be immediately accretive to cash flow, offer some upside potential (forced and natural appreciation), and fit our operating strengths.
We research the markets first, then let that guide us to the property type that fits the demographics and our investment criteria.
Once we’ve identified the market and the property type, next we do extensive tenant research. Regardless of property type or credit rating, the way we look at it is when we get involved in long-term leases with corporate tenants we are betting on their continued success for our own. That means I spend a lot of time learning about how the tenant’s business makes money, and whether the outlook for that business model is positive over the long haul. Lots to consider there, especially with the rate of change in a global marketplace.
All in all I think this is one of the most exciting times I’ve ever seen in my 25+ years in this business, and a great time to be out shopping markets and properties. The capital markets are stable and liquid, and supply is concomitant with demand in most of the small markets we play in. That combination makes for my favorite condition… multiple exit strategies for the ones I get wrong!
ray